Covid-19 And The Impending Avalanche Of Force Majeure Clauses, Declarations
The Oasis Reporters
March 29, 2020
By Dr. Jekwu Ozoemene
On Thursday a friend (seeking clarification during a debate) asked me to know what happens to a subsisting bank loan in this era of COVID-19 if the borrower cannot service it.
He wanted to know if it is automatically restructured by the bank.
My opinion was that the forbearance has to come from the industry regulator and the company’s auditors. It has to be a Central Bank policy for commercial banks to restructure loans that went into default due to the COVID-19 pandemic.
The reasoning behind my take is that though there should be a Force Majeure clause in the loan contract but given that this is usually a template drawn up by the bank, I doubt that it will give the borrower much wriggle room. Not so much for the big firms, but especially so for the SMEs who do not have leverage to negotiate.
A typical Force Majeure provision is intended to exclude liability for non-performance caused by specified occurrences beyond the reasonable control of a party. This will include events such as a war/armed conflict, strike, riot, crime, plague, explosions or an “Act of God”; hurricane, flood, earthquake, famine, volcanic eruption, etc.
So the answer to my friend’s question will depend on whether or not the contract in question contains Force Majeure provisions that covers the borrower and relieves a party from the obligation to perform the contract if the non-performance is caused by any of the events mentioned earlier.
If a Force Majeure clause covers the client in the loan contract then the inability to repay the loan must be directly traceable to the COVID-19 pandemic, thus loans that were primed for default or bad ab initio will not qualify. If not, I can imagine how “banksters” will abuse such a clause to further window-dress existing toxic assets.
Yesterday (being Friday) another friend chatted me up with yet another dilemma.
This friend is an entrepreneur (SME) who had received an 80% advance payment in late February for a job she was supposed to deliver tomorrow (March 29, 2020) at a birthday party.
The client had just sent her a message requesting a full refund of the advance payment given the prevailing circumstances (note that her client has no need for this service after March 29, and evidently does not see the party happening in the near term).
My friend was understandably distraught. She was clear to the client that she didn’t have money to make the refund right now and confided in me that she is not quite sure if she is contractually obliged to make the refund.
When I asked if she had a “no-refunds policy” for her business, her response was “no”, and being an SME, there was also no underlying formal contract.
So while I sympathized with her, in the first instance (and for relationship management sake), my opinion is that she has to refund the advance in full as Force Majeure cannot be invoked if it is not expressly stated in a contract.
If my position is correct then this should be a wake-up call for small businesses to ensure that they draw up contracts for such orders and advance payments.
I also asked if she had incurred any cost (like prepayments, etc) for the job she was to deliver tomorrow. If this is the case then based on the common law doctrine of “frustration of contract”, the contract will still be terminated however all expenses incurred before the event frustrating the contract occurred may be retained.
You can imagine that this will often be decided by a court of law and the deal sizes for SMEs makes incurring the requisite legal charges unattractive.
Today another friend (a former Company Secretary to a commercial bank) sent me an article on useful insights on corporate governance issues in the context of the COVID-19 pandemic. In the course of our chit-chat, I was informed that a customer of a bank called her to inquire if the Force Majeure clause can be activated to cancel her debt obligation to her bank.
This is akin to the discussion I had on Thursday and appears to be a discussion that will keep reoccurring over the coming days and months.
One thing I must note on these bank borrowings is that even if the underlying loan contract has a Force Majeure clause, it must be for specified event types; the party affected by the Force Majeure is to take steps (as stated in the contract) to cure the event of default or mitigate the losses; and when the event of default has fully crystallized, must follow the procedure stated in the contract to enjoy the prescribed relief.
But again, this is all my layman’s opinion as I am not a lawyer, however from the discussions I held with my three friends, it is clear that post the current COVID-19 pandemic, for the big and medium sized firms, a good number of Force Majeure or Frustration of Contract actions will be triggered, resolved amicably, and a lot may end up in court.
My question is, what happens to the small businesses?
How can they be protected?
A saving grace for SMEs however is that given typical small loan sizes, banks will find it exorbitant to pursue individual court actions against them. The flip side is that a borrowing default will negatively impact on the SME’s ability to borrow from the industry again.
For the SME Business to Business (B2B) and Business to Consumer (B2C) failed contracts, money may be lost to vendors and suppliers if the common law doctrine of “frustration of contract” is applied. Even agreeing to this may lead to lost relationships, unintended additional costs and long-drawn litigations.
For the commercial banks…you are about to revert to the adage we learnt in 2008 through a bitter and painful process “the return of the money is better than the returns on the money”.
I will not sugar-coat this.
It is about to get ugly.
Written by Dr. Jekwu Ozoemene.
One time Deputy Managing Director of a bank in Rwanda, and later , Managing Director of same bank in Zambia. He’s a Financial Advisor and runs financial consultancy services.
Dr. Jekwu recently appeared on TEDx Port Harcourt.
